OREANDA-NEWS. Fitch Ratings says the recent profit warning by a Chinese city gas operator after its tariff adjustment was not immediately approved by the local government underscores the importance of scale and geographic diversity for Chinese distribution utilities' credit profiles.

On 16 March 2015, Hong Kong-listed China Oil and Gas Group (COGG) issued a profit warning after the Xining government in Qinghai Province did not approve an immediate tariff adjustment for the company after the National Development and Reform Commission (NDRC) increased the company's natural gas procurement cost - the city gate natural gas prices - in 2014. The local government only approved the tariff adjustment for the company on 15 March 2015.

COGG's financial performance in 2013 was also impacted by a delay in passing through costs to end-users. The company estimated the delay of cost pass-through in 2H13 reduced profit attributable to owners of the company by about HKD30m.

Although other city gas operators such as China Resources Gas Group Limited (CRG; BBB+/Stable), ENN Energy Holdings Limited (ENN; BBB/Stable) and China Gas Holdings Ltd (CGH), have experienced some delays in implementing price adjustments in some of their service areas, their overall cash flows were only marginally impacted in the immediate term given their much more diverse footprints.

Large operators such as CRG, ENN and CGH have the benefits of substantial diversification in geographic exposure through their large number of projects, which number well over 100. Furthermore, larger annual operating EBITDA and balance sheets also help them absorb the short-term impact from any delays in passing through higher procurement costs. COGG's smaller scale and a concentrated exposure in Qinghai, which accounted for about 47% of its gas sales volume in 2014, resulted in a more pronounced short-term financial impact from delays in tariff adjustments. COGG in 2014 had total gas sales volume of 2.5 billion cubic meters, compared with the larger players - CRG with 13.3 billion cubic meters, ENN with 7.9 billion cubic meters and CGH with 8.4 billion cubic meters (annualised based on the six months ended 30 September 2014).

The NDRC is responsible for approving prices that city gas operators can charge for their services, which impacts utility operators' economics and cash-flow generation ability. However, local pricing bureaus, which fall under the purview of local NDRCs, may adjust national policies to suit local circumstances, which may result in some delays in the timing of execution of price adjustments.

Eventually, though, Fitch believes city gas price adjustments will be passed through to end-users, driven by the nation's goals to use cleaner energy sources and the need to encourage investments in the sector. However, diversification is an important risk mitigant for distribution utilities in China given the potential delays in tariff adjustments following changes to supply costs.